Moreover, as with all other scores, the credit team not only analyses the ESG risks, but also attempts to price them on an outright and nominal basis. If the analyst can provide a choice between two names at similar spread levels but of varying ESG quality, the portfolio manager will choose the one with the better ESG scores; the portfolio manager is less likely to select or build significant positions in names with a troubled ESG record.
The Public credit team do not have any norms-based exclusions for the mainstream credit funds. However, they do upload the quarterly controversial company reports produced by EOS to the coverage database in order to ensure that the analysts are aware of any changes to the list and capture materiality in financial risk from non-fundamental factors.
The Private Debt team considers ESG items as part of the credit analysis undertaken for each potential investment. ESG considerations are tabled at the Private Debt Investment Committee as part of the research presented for all new transactions.
For our Direct Lending team, the key is to identify meaningful ESG risks, both current and potential, before investing. Due to the difficulty of divesting and the capped upside, it is important to manage the downside ex ante. The Direct Lending team operates a three-pillar approach to ESG analysis:
- Excluded Industries: The Direct Lending strategies are prevented from investing in any transaction exposed to certain industries and practices, including gambling, tobacco, alcohol, weapons, GMO, animal testing and businesses with a negative ecological footprint on natural habitats. This is because the Direct Lending team does not think that investors are remunerated for the ESG risks associated with these industries.
- Enhanced Due Diligence: Any potential investment exposed to certain industries is subjected to enhanced due diligence, including engaging with the Federated Hermes Responsibility team and EOS, as appropriate. These industries include energy, chemicals, forestry and agricultural commodities, manufacturing and mining and metals.
- Transaction-specific ESG Analysis: Each potential investment is analysed at a granular level across the three ESG components, with the analyst identifying potential company and sector-specific ESG risks and mitigants. The analyst assigns a low, medium or high rating to each component. The Direct Lending team do not invest in companies with a ‘high’ risk assigned to any of the E, S or G factors pre-investment.
Information on flood risk is provided by the borrower along with professional independent valuation, EPC rating and financial information as a condition precedent to lending and then annually throughout the term of the loan. Flood risk for UK is measured in line with the UK Environment Agency flood maps and can be verified by Federated Hermes through this source. If any risk of flood is identified, a mitigation or action plan is required from the borrower and reviewed at least annually throughout the term of the loan.